Clifford Chance

Companies have been watching to see where ESG-related risks would materialize. Those risks are starting to materialize off the back of the SEC's aggressive regulatory and enforcement posture on "greenwashing" with enforcement actions regarding misstatements and disclosures. These actions should be a wake-up call to companies in the US and beyond as now is the time, if you're not already, to closely consider the regulatory, enforcement, and litigation risks associated with both the SEC's current posture and the looming formal SEC disclosure proposals.

The US Securities and Exchange Commission ("SEC") has taken an aggressive regulatory and enforcement posture on environmental, social, and governance ("ESG") issues. Recent SEC actions against US and non-US companies for "greenwashing" (conveying a false impression that a company or product is environmentally friendly or failing to accurately describe the company's ESG practices) sound a warning for companies active in ESG investing or that make ESG-related public statements, and offer a preview of the significant risks awaiting if the agency can finalize its unprecedented new disclosure requirements for public companies, investment managers and funds.

The SEC Division of Enforcement established a Climate and ESG Task Force in March 2021. Among other things, the Task Force reviews disclosure and compliance issues relating to investment advisers’ and funds’ ESG strategies and identifies material gaps or misstatements in climate risk disclosures by public issuers. Just a year after its creation, the ESG Task Force is credited with bringing two groundbreaking greenwashing actions against a large US investment manager and a non-US public issuer.

The SEC published a settlement order with a major US investment manager on May 23, 2022, that required it to pay $1.5 million to resolve charges that it made material misstatements and omissions to investors concerning its ESG practices. While the manager neither confirmed nor denied the SEC's findings, the order states that, from July 2018 to September 2021, the manager represented or implied that all investments in its funds underwent an ESG quality review when, in actuality, a number of investments did not have an ESG quality review score at the time of investment. The manager agreed in the settlement to cease and desist from similar violations and to be censured.

This announcement follows a recent civil action filed in the U.S. District Court for the Eastern District of New York against a South American mining company on April 28, 2022, alleging that the manager made or implied misleading statements in its "sustainability reports, periodic filings, and other [ESG] disclosures" about its "commitment to sustainability" and safety after a dam collapse. The complaint further alleges that the collapse significantly harmed investors by triggering a loss of over $4 billion in the company's market capitalization. In an illustration of the multi-front threat posed by securities actions, the SEC complaint is based on arguments previously made by private litigants in a civil shareholder class action lawsuit.

These cases are likely the leading edge of the Task Force's announced focus on statements relating to climate risks and sustainability, as the Task Force proactively searches for cases through data mining and by soliciting "tips, referrals, and whistleblower complaints."

These greenwashing risks will only increase as the SEC adopts formal ESG-related reporting requirements. On March 21, 2022, the SEC proposed disclosure requirements that it claims would enhance and standardize the climate-related information that SEC-registered entities provide to investors. As proposed, the reporting requirements would offer companies only limited protection from litigation through "safe harbors" for certain disclosures. On May 25, 2022, the SEC separately proposed rules requiring certain investment managers and funds to: (i) include specific disclosures regarding ESG strategies in fund prospectuses, annual reports, and adviser brochures; (ii) implement a layered, tabular disclosure approach for ESG funds to allow investors to compare ESG funds at a glance; and (iii) disclose the greenhouse gas emissions associated with their portfolio investments. The investment manager proposal does not include any disclosure "safe harbors."

The new rules are only at the proposal stage; they are likely to change and will almost certainly be challenged in US courts. But if they go into effect, even in modified form, the rules are widely expected to be some of the most significant new public company and investment manager disclosure and compliance requirements in a generation. Such wide-ranging new rules will no doubt lead to legal actions by both the SEC and private litigants alleging that public companies or investment managers failed to satisfy the disclosure requirements applicable to their businesses.

Companies should take steps now to prepare for these impending rules and new litigation risks by, among other things:

• Focusing closely on their public disclosures related to ESG issues.
• Ensuring that targets and commitments with respect to ESG issues are reasonable and achievable.
• Examining their written supervisory policies and procedures around ESG topics.
• Conducting ESG risk assessments to identify opportunities for risk management and mitigation.
• Closely monitoring the SEC's proposals and working with industry groups to comment on and, to the extent possible, improve the final SEC rules.